Summers' Warning?

In a recent NBER working paper, "How Globalization Affects Tax Design," (WP # 14664), James R. Hines, Jr. and Lawrence H. Summers point out that the increasing mobility of capital makes economic activity more sensitive to tax rates, thus increasing the deadweight loss from a given tax rate. The rapid pace of globalization, they write, means that "all countries are becoming small open economies." This means, they write, that "the use of expenditure taxes [as opposed to taxes on personal and corporate income] is likely to increase."

They also assert, without providing evidence, that globalization increases the demand for government spending.

Is there a way to avoid expenditure taxes and, instead, keep having high marginal tax rates on personal and corporate income? In their last paragraph they suggest a way out, writing:

International agreements have the potential to play significant roles in these strategies. It is already the case that governments cooperate in international settings such as the World Trade Organization to promote international trade and investment, and bilateral and multilateral tax agreements and initiatives serve the function of facilitating tax enforcement and avoidance of double taxation of international income. Doubtless governments will come to rely more heavily on international agreements in the years to come, but it remains to be seen whether they will accelerate or offset the recent trend in the direction of expenditure taxation.

In other words, Hines and Summers seem to be suggesting that governments get together and form tax cartels that would lessen the competition between governments for economic activity. Given Summers' current role as head of President Obama's National Economic Council, this article could well be more than an academic exercise. Summers bears watching.

I'm not scared. Collusive agreements rarely work and the higher the probability of countries attracting capital by lowering taxes, the lower the probability that they will collude.

Add to the mix the fact that most powerful countries have plenty of enemies with no interest in colluding for political reasons and the fact that alliances are rarely kept in the long run, and I don't think there will be enough collusion to eliminate tax competition.

The suggestion of tax cartels strikes me less as "scary" than as "desperate."

I suspect that tax cartels are no more likely to be successful than any other cartel that tries to enforce its dictates without the power of the state. In the case of a cartel of governments there is no single world state to enforce participation in the cartel.

The examples of failed cartels in these circumstances far outnumber those of successful ones.

BTW, based on the synopsis of the paper this is good news: strong forces pushing toward consumption based taxes.

Excuse me if I'm wrong here, but the only people who pay U.S. Taxes are U.S. corporations and individuals. Increasing the marginal tax rate on an individual won't encourage him to invest outside of America, he still pays the same capital gains tax regardless of where he invests. Unless the American actually emigrates and changes citizenship, it doesn't matter where he invests, he pays the same tax.

Have I missed anything here?

Now, one could argue that higher corporate tax rates could make it more likely that incorporations occur outside of the U.S. BUt the individuals who work for those corporations will still pay taxes to the American government, so that income isn't lost, only the income that is lost from the corporate tax rate.

But that corporation must be making a profit to pay taxes anyways. Also, there is little to no threat of the largest American companies incorporating outside of the U.S. because of the stigma that would be attached to them would cause them to lose a large amount of business in the U.S.

So what are we left with? Small companies that operate internationally may find it useful to incorporate somewhere else, but the loss of their tax receipts is unlikely to be larger than the loss from lowering corporate taxes. Individuals pay the same capital gains rate regardless of where their investment occurs, and because they have more information in the U.S., they are more likely to invest here (both because of greater information and less risk). Large American Corporations won't change their national status due to negative stigma.

I fail how higher taxes on American makes them more likely to invest outside of America. It just doesn't make sense.

As you obliquely note, Americans are unusually screwed when it comes to income taxes because we, almost alone among nations, apply global taxation on individual and corporate income.

These problems are somewhat muted by the fact that our income taxes are (still) relatively low and our corporations don't pay taxes on foreign profits that aren't repatriated.

Still, in economics you must think at the margin, because that's how people behave. At the margin, we're losing horrendous amounts of investment in this country because GE can defer paying among the highest corporate taxes on earth by reinvesting their foreign profits in Ireland or India. And the U.S., which used to be a magnet for all kinds of talent is seeing a sharp drop-off in professionals applying for green cards because they don't want to check into our Hotel California of tax regimes.

These things don't make or break our economy, but they have a definite impact. What does is it say when the global creme-de-la-creme no longer want to invest so much of their personal or financial capital in a country that so aggressively lays claim to it?

I know the blue collar working man tends to be reluctant to see his tax money invested in government funding that he will never see. Also, in regards to the comment that MHodak made about large corporations slipping through the tax loop hole by reinvesting their foreign profits in foreign countries. Why not allow individuals and corporations to invest their own tax money into a government funding program that they personally support. This way, people will feel less shisted, if they support the cause.

Well, I think thats kind of a false explanation, MHodak. For example, the outflow of dollars to the rest of the world from our trade deficit are made up in foreign investors buying American assets. Clearly someone finds investing the U.S. worthwhile.

As for companies reinvesting foreign profits abroad, they invest based on the rate of return they expect. GE invests abroad, as does MacDonalds, Walmart, etc. because the market for their goods is basically tapped out in the U.S. Lowering the tax rate would merely increase their profits without creating an incentive to "invest" in the U.S. Companies invest based on expected rate of returns, and if they can't make any more profit in the U.S., why not let them go abroad and increase the economic dominance of American Companies worldwide. And they often do repatriate that income in the form of wages to their management, so we should encourage them to expand their reach as far as possible.

I don't think there is a realistic argument for why reducing tax rates in the U.S. would increase investment by a substantial enough amount to make up for the decrease in tax revenue. Fact is, the American market for Consumer Goods is nearly tapped out. Walmart can only expand into places where they haven't already maximized their profit. Starbucks is a great example of what happens when a company over invests in a single geographic area.

And we aren't attracting talent from the rest of the world because the U.S. research sector has been languishing as places like India and China lavish researchers with money, either through direct subsidy or specific tax breaks, to work there. Obama clearly has the right ideas on this front by quadrupling science fellowships, increasing available greens cards, and directly subsidizing research. Besides, the reason America remains so strong in technological leadership at all is because of the strength of our patent laws and the powerful distribution system of American Pharmaceutical and Chemical companies, both of which aren't going to disappear because of tax rates.

Low tax rates make sense for under-developed countries and markets, as they become more attractive an investment relative to other under-developed economies. But it makes little sense for an economy where there is little room for anything other than productivity growth.

Must we always think at the margin? True, tax policy will have a marginal effect on immigration, investment, and emigration. But the great majority of people and corporations are nowhere near a marginal decision.

I live in the Bahamas about 8 months a year. The country has tax and immigration laws specially designed to attact foreigners and foreign investments. Yet the country remains underpopulated, and their best and brightest flee. Good laws (and a marvelous climate) cannot overcome the paucity of wealth in a position to relocate.

You might argue that they have attracted me, but I'm just a scruffy sailor whose annual gross income seldom tops $20,000. Hardly their target!

Summers is apparently a genuine socialist. Having described, and economically justified, what ought to be done (consumption tax), he instead proposes a vastly new level of coercion with no escape anywhere on the planet. These guys are going to run our government for 4 years, probably 8.

I'd really like to hear David's take on this. Why exactly will higher taxes on capital gains influence individuals?

And can large companies really incorporate overseas without a fear of the consequences? I feel like what was put forward in the original post was a far too simplistic argument for tax cuts, without much thought behind whether they would incentivize investment enough to make up for lost tax income

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